The SEC, Gatekeepers and Saying Something
The SEC has long sought to enlist professionals as the advance guard of its Enforcement Division. The point is understandable: auditors, attorneys and other professional consultants are typically at the company long before Commission investigators and often have a better opportunity to halt wrongful conduct at an earlier date. As the Ninth Circuit said years ago when considering such an argument: “To accept the SEC’s position . . . [would make accountants] an enforcement arm of the SEC. We can understand why the SEC wishes to so conscript accountants. Its frequently late arrival on the scene of fraud and violations of securities laws almost always suggests that had it been there earlier with the accountant it would have caught the scent of wrong-doing and, after an unrelenting hunt, bagged the game . . . The difficulty with this is that Congress has not enacted the conscription bill that the SEC seeks . . .” SEC v. Arthur Young & Co., 590 F. 2d 785788 (9th Cir. 1979).
While that conscription bill still has not been written, a group of five cases centered on a fraud and audit failures might propel the discussion. Alternatively, those case may give new meaning to the often repeated slogan: “See something, say something.”
The cases and participants: SEC v. Pence, Case No. 1:15-cv-07077 (S.D.N.Y. Filed Sept. 9, 2015) names as a defendant Stephen Pence, the former U.S. Attorney for the Western District of Kentucky and later lieutenant governor of that state. Salvatore J. Zizza and Ronald Heineman, both at one time the CEO of General Employment Enterprises, Inc. or GEE, named as Respondents in: In the Matter of Salvatore J. Zizza, Adm. Proc. File No. 3-16799 (Sept. 9, 2015); In the Matter of Ronald E. Heineman, Adm. Proc. File No. 3-16798 (Sept. 9, 2015). Audit firm BDO USA, LLP, and five of its auditors who participated in the audits of GEE, were named as Respondents in two separate proceedings. In the Matter of BDO USA, LLP, Adm. Proc. File No. 3-16800 (Sept. 9, 2015); In the Matter of Sean C. Henaghan, CPA, Adm. Proc. File No. 3-16797 (Sept. 9, 2015). The other Respondents, in addition to Mr. Henaghan who was the GEE engagement partner, are: John Rainis, the concurring reviewer; Leland Graul, the firm’s national director of accounting; James Gerace, the regional technical director of the firm; and Wendy Hambleton, BDO’s national SEC practice director.
The facts: The facts trace to early 2009 when Wilbur Huff, along with Messrs. Heinman, Zizza and an unnamed associate, discussed obtaining control of GEE. Mr. Huff was a convicted felon who pleaded guilty in the Western District of Kentucky while Mr. Pence was the USAO. The idea was to have GEE acquire a number of private professional and temporary staffing companies. Those would include entities controlled by Mr. Huff. All of the acquisitions would be rolled up into the public company. While Mr. Huff would be the “money guy,” his felony conviction, along with the fact that he was named as a defendant in a 2008 fraud suit by the SEC, would present issues in a public company. Mr. Pence, acting through PSQ, LLC, would be the face of the public company.
On July 1, 2009 PSQ acquired a majority of GEE’s shares as well as the right to appoint a majority of the board of directors. In exchange for serving as the face of the company, Mr. Pence was paid at least $500,000 by Mr. Huff. Following the closing GEE opened a checking account at The Park Avenue Bank. Mr. Hugh had business dealings with the president of that bank, Charles J. Antonucci, Sr. Mr. Huff was one of the authorized signers on the account.
In July 2009 Mr. Huff had GEE transfer $2.3 million from its Park Avenue Bank account to Park Avenue Insurance. That entity was owned by Mr. Antonucci. The $2.3 million represented most of the firm’s cash and a significant portion of its assets.
In the fall of 2009 BDO began auditing GEE’s financial statements for the fiscal year ended September 30, 2009. The engagement team was led by Mr. Henaghan. During the audit the engagement team learned that the $2.3 million was unaccounted for when the CFO advised them in November that a 90 day non-renewable CD of the company had not been repaid by the issuing bank. The documentation was missing. The auditors also learned that the issuing bank had no record of the CD. Management and various board members added to the confusion by giving the auditors a series of conflicting explanations about the missing asset.
Mr. Huff, in an effort to induce the auditors to sign off on the audit, arranged a series of transfers from various entities, replacing the $2.3 million. When the audit team questions Mr. Pence, then the chairman of GEE, about the missing money and the subsequent transactions through which it was returned, he claimed not to know. Yet he told Mr. Huff that Mr. Antonucci must have stolen the money after which he received assurances that it would be replaced. Others at the company furnished conflicting accounts as to how the funds were returned to GEE.
BDO engagement partner Sean Henaghan and concurring partner John Rainis consulted with senior BDO partners. Those included James Gerace, Leland Graul and Wendy Hambleton. The audit firm then delivered a letter to GEE demanding an independent investigation directed by the audit committee. Days later, however, the firm withdrew the demand an issued an unqualified audit opinion.
Subsequently, Mr. Pence executed the 2009 GEE Form 10-K. It falsely stated that the company had purchased a $2.3 million CD and that when it matured the bank had not honored it for unknown reasons. The filing also stated that the company had received its money back through a non-recourse assignment of the CD for face value to an unrelated party.
Subsequently, a criminal complaint was filed which named Mr. Antonucci as a defendant. That complaint stated that: the GEE $2.3 million CD never existed; the bank president had given a false confirmation to BDO; GEE’s funds had been used to try and conceal a loan default; and that the entities transferring the $2.3 million back to GEE were related to the conspiracy alleged in the complaint. The criminal complaint also alleged that Mr. Pence was involved. Later Mr. Antonucci pleaded guilty. Although BDO learned about this information, the firm did not conduct any additional procedures to determine if it impacted the issued opinion. In 2010 the audit firm issued another unqualified audit opinion on GEE’s financial statements.
The charges and disposition: SEC v. Pence alleges violations of Exchange Act Section 10(b). The action is in litigation. In the Matter of BDO alleges violations of Exchange Act Section 10A and 13(a). The firm resolved the action, admitting to the basic facts alleged in the Order. The firm will also implement a series of undertakings which include a complete review and evaluation of the sufficiency and adequacy of its quality controls, the preparation of a report detailing revisions to its policies, the retention of an independent consultant, certain undertakings regarding audit training and annual certifications regarding the sufficiency of its policies for 2017 and 2018. The firm also consented to the entry of a cease and desist order based on the Sections cited in the Order as well as to a censure. BDO will pay disgorgement of $536,000, prejudgment interest and a penalty of $1.5 million.
Each BDO auditor named as a Respondent in In the Matter of Henaghan also settled. The Order alleged violations of Exchange Act Sections 10A and 13(a). Each Respondent consented to the entry of a cease and desist order based on those Sections. In addition, each auditor was denied the privilege of appearing and practicing before the Commission with a right to request reinstatement after: Mr. Mr. Henaghan three years; for Mr. Rainis two year; and for Messrs. Grace and Graul one year. Each Respondent will also pay a penalty: Mr. Henaghan: $30,000; Mr. Rainis $15,000; and Messrs. Gerace and Graul and Ms. Hambleton: $10,000.
The Orders in In the Matter of Zizza and In the Matter of Heineman each allege violations of Exchange Act Rule 13b2-2. Each Respondent consented to the entry of a cease and desist order based on that Rule. In addition, each man will pay a penalty of $150,000.